Two brothers, Adam and Robert Merkle, began A&R Plumbing Ltd. (ARP), a private company, approximately five years ago. At the time, Adam had recently graduated from a business program with a specialization in accounting and Robert had just completed a plumbing apprenticeship. Adam performed all administrative tasks (inventory ordering, accounting, payroll, etc.) while Robert provided the skills of the trade. ARP had a very slow start and for the first two years all revenues were generated by providing emergency plumbing services. ARP operated at a loss for the first two years of operations. In the third year, ARP landed several large subcontractor deals with various home builders and began installing plumbing in new homes. ARP began to be profitable. In June 2011, Adam and Robert's business relationship started to deteriorate and they were having trouble agreeing on any business decisions. Adam decided that it would be best if he left the business and Robert agreed to pur- chase Adam's share of ARP. The company shares were privately held and were not traded actively on the market so Adam agreed to sell his shares in the business for an amount equal to 10 times the profit of the business for the year ended December 31, 2011.
The company prepares its financial statements in accordance with Accounting Standards for Private Enterprises. In January 2011, ARP purchased 20,000 common shares of Canadian Plumbing Supplies Ltd (CPS). CPS is a plumbing supply distributor and its shares were acquired for $100,000. The shares represented a 20% ownership holding of CPS and the shares are traded actively on the Toronto Stock Exchange. Since the purchase, neither Adam nor Robert has been actively involved in any decisions related to CPS's operations. However, once Robert obtains full control of ARP, he plans on using ARP's 20% share to obtain a seat on the CPS board of directors. He wants to use his board position to develop a referral system whereby CPS will refer customers to ARP for plumbing services. At December 31, 2011, CPS's shares were trading for $4.50 each.
CPS's year end is December 31. For the year ended December 31, 2011, CPS reported a loss of $30,000. CPS did not declare any dividends. Adam had accounted for the investment in ARP using the cost model.
Instructions
(a) Robert has come to you, an independent public accountant, for advice. He would like you to assess the accounting choice that Adam has made for the investment in CPS.
1. Describe the acceptable accounting policy choices available under ASPE to account for ARP's investment in CPS. Is the cost model an acceptable method under ASPE for this investment?
2. Discuss whether Adam's selection of the cost model is an indication of any bias he may have. Explain.
3. Which accounting policy choice do you think Robert would prefer? Why?
(b) Explain how the accounting policy choices available to ARP for its investment in CPS might be different if it reported its financial results in accordance with IFRS.